But there is an alternative. It’s one that might appease Germany, which doesn’t want the richer nations to be dragged down by countries such as Portugal and Greece. It could also placate the European Central Bank. In order to prop up sovereign debt markets, the ECB has been buying bonds in the secondary market to great effect, but that’s not the central bank’s job, and it would prefer the governments to take care of such business on their own.

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The solution is turning the euro zone’s current bailout fund, the European Financial Stability Facility, into a bank.

Even at its expanded size of €440 billion, the EFSF is too small to provide the huge amounts of liquidity needed to keep financing flowing to Italy and Spain over an extended period–Italy alone has gross financing needs that approach €400 billion a year. The EFSF rests on the triple-A borrowing power of six euro-zone nations, led by Germany and France. If leaders miraculously decide to increase the fund’s size, it will only heap more of the burden on those countries’ shoulders. Too much, and France could lose its own triple-A status, in turn placing yet more onus on Germany–a domino effect that would render the fund useless, says Daniel Gros of the Centre for European Policy Studies, who has proposed the bank idea.

But, by turning the EFSF into a bank, the EU could ensure that troubled countries have access to financing. It would buy up struggling countries’ bonds in the secondary market, and like any other bank, use them as collateral with the ECB to borrow more money. Leverage. The the EFSF vehicle would be making the decision of when to buy bonds, and how much. The ECB would play its role as lender of last resort. And euro-zone member states would get their financing.

“Europe’s leaders wanted to be generous to Greece, but the supply of cheap funds is limited. Not everybody can be served this way,” Mr. Gros said in the report.

And to avoid the imminent threat of a total breakdown of the interbank lending market, the euro zone needs “a massive infusion of liquidity.”

To be sure, this solution only works if Spain and Italy don’t need a full bailout of their own, only secondary-market intervention.

“A full bailout of Italy and Spain seems to us difficult to contemplate under any circumstance. It is also unlikely because the savings surplus of Germany (and other North euro zone) has to go somewhere,” said Gros in an email.

Comments (5 of 7)

I had to circle back to this one and re-read it. For the last time......the problem is not that we don't have enough debt. It's that we have too much. Levering out the EU through another abstraction isn't going to help the problem. It's just going to hide for a while. We need some creative thinkers here and visionary leadership. Bold new actions are needed.....not more loans. What's needed is a 50% reduction in all EU debts: public and private. Bond holders and creditors would receive newly minted cash to replace the holes in their balance sheets. Yes, the EU would print it and yes that would effectively devalue the Euro. Other options?

5:29 am August 24, 2011

Bernie wrote:

Because this EFSF-bank should be able to lend unlimited from the ECB, it sure will need mr. Madoff as its advisor.

9:11 am August 23, 2011

Lyst wrote:

Yes. A independent and a dependent Bank. The Government will figure out a way to print their own money.

11:56 pm August 20, 2011

DaarkStar wrote:

So...two central banks for the Euro? The Bad Bank of Europe: EFSF. The Good Bank of Europe: ECB. I need to think this through. We all do.

About Real Time Brussels

The Wall Street Journal’s Brussels blog is produced by the Brussels bureau of The Wall Street Journal and Dow Jones Newswires. The bureau has been headed since 2009 by Stephen Fidler, who was previously a correspondent and editor for the Financial Times and Reuters. Also posting regularly: Matthew Dalton, Viktoria Dendrinou, Tom Fairless, Naftali Bendavid, Laurence Norman, Gabriele Steinhauser and Valentina Pop.